Market volatility and some good news, perhaps

For thousands of years, humans have benefited from an abundance of paranoia. This trait has quite literally kept us alive. If, for example, we were walking through the woods and something appeared that resembled a poisonous snake, we determined, over time, that we would be better off assuming it is a snake and avoiding it (even though probability may suggest otherwise). Over time, our brains evolved to accommodate (and encourage) the fear instinct, and hence, the ‘fight or flight’ portion of our brains evolved.

It is, perhaps, this same instinct that helps explain why we are more likely to read an article if the article has a more dire tone. The headline “Crisis Strikes” will have a higher viewership than, say, “All is Still Fine”. To underline this further, the morose publishing saying “if it bleeds, it leads” is perhaps illustrative.

It is precisely this dynamic that has caused this recent period of market turmoil to be so rapid and significant, and yet it is also this dynamic that perhaps offers opportunities to those that can remain calm in times of such peril.

Accordingly, what follows is an update on how the outbreak is proceeding, and the impact to markets thus far.

For the more impatient among us, let me begin by offering this: we are beginning to see signs that the quarantine is working. Global growth rates are slowing and, more locally, the growth rates in US also are slowing.

What follows is an update on the novel corona virus (COVID-19), as well as a quick review of the markets. Given we have seen some changes in the former (that are not being focused on), and some stabilization in the latter (which is being heavily focused on), we will spend a bit more time on the former.

The state of COVID-19 spread

Therefore, let’s begin with a quick update on the nature of the crisis. As of the night of March 31:

1) The novel coronavirus (COVID-19), now present on every continent except Antarctica, has infected nearly 855,000 people and killed more than 42,000 people.¹

2) There are now more cases outside of China than inside China.

3) In the United States, there are now a bit more than 164,000 cases along with a little more than 3000 deaths.²

Those numbers are understandably unsettling and help to explain why markets have been as volatile as they have been. Forecasting out in the very near term, by Friday there will likely be more than 278,000 cases, and by Sunday we will be approaching 400,000 cases. That is the unfortunate power of exponential math if things do not change.

And yet…they are beginning to change.

There are now more than 280 million Americans under stay-at-home orders. Businesses, schools, churches, sports, and the like are completely shut down. Residents nationwide (some areas more than others as this is still state by state) are required to remain in their residence with the exception of grocery shopping, medical treatment, and other essential tasks.

And we are beginning to see it in the data. Chart 1 below shows the early signs of stabilization, and the reduction in the growth rate.

The global case growth rate peaked at around 20 percent (March 22 ^nd), and has declined to around 12 percent per day. The impact of that difference is dramatic.

At 20 percent, the global case load was doubling every four days. At 12 percent, the global case load is doubling every six days, and as the rate continues to fall (assuming we do our jobs and stay at home), the number of days to double will continue to increase. Yes, the rate is still way too high, but it is beginning to slow. For comparison, Italy was doubling every four days (daily growth rate of 25 percent) just two weeks ago…and it is now doubling every eleven days (daily growth rate of 6 percent).

Quarantine is working. Social distancing is working. The requirement to shelter at home is working. We are beginning to see those changes reflected in growth rates, and markets are beginning to reflect that optimism.

The importance of distancing

Before we move on, however, I would be remiss in not mentioning the role we all play. An epidemiologist explained it to me as follows. There are now two groups in the world: Group A and Group B. Group A consists of the medical professionals on the front lines, and Group B is everyone else. Our job, as Group B, is to help Group A do their jobs. How? By staying home. By remaining vigilant. By not violating the shelter-at-home orders. By mitigating the risk that we continue to spread COVID-19.

To underline that point, we have been modeling the impact that “peak lockdown” has been having on the growth numbers. We define “peak lockdown” as the moment governments began to require schools to close, businesses to close, etc. While there are some regional differences, in the United States it was March 13, in Hubei, China, it was January 23, and in Italy, it was March 9.

Although there is some variance between countries, the growth rates tend to have a lag between when the country is locked down, and when the cases begin to not grow as quickly. China was able to bring the growth rates down quickly, and after a tough start, Italy has also dropped their growth rates dramatically. Note: China is now seven weeks past their lockdown, and the chart above is appropriately truncated.

Market reaction

Thankfully, the U.S. is now beginning to see a similar contraction (after a fairly bumpy beginning), and markets have begun to reflect that reduction in uncertainty.

As evidence, Chart 3 shows the volatility index. As a reasonable proxy for fear and uncertainty, the VIX is demonstrating that investors are beginning to breathe a (cautious) sigh of relief.

The index peaked on March 16 at around 83, and it closed on March 31 at 51.65. We are clearly not out of the woods, but we are beginning to see positive stabilization in the market as growth rates of the virus slow, and uncertainty begins to abate.

Lastly then, let us zoom out to the chart that offers perhaps the most important lens of all. Chart 4 shows us the total returns of investing in the Standard & Poor’s (S&P) 500 since 1940.

Source: Bloomberg⁶

This chart demonstrates one of the most wonderful aspects of investing: markets historically recover. Black Monday in October 1987 was an unprecedented event as the U.S. stock markets fell almost 22 percent in a single day. The tech bubble crash of 1999/2000 was a remarkable destruction of value, and amid the Global Financial Crisis of 2008, pundits and commentators were speculating as to whether we had seen the end of capitalism as we had known it.

And yet, if we zoom out over the long term, equity markets are a remarkable provider of investment returns. This is the lens through which we should make our allocation decisions. During the darkest moments, we should remember why we made those decisions…and adhere to the plans created in those periods of less turmoil.

I do not know how much damage will be tallied when this is over, but I do know that we are beginning to see signs of stabilization, and I, for one, remain optimistic of our eventual recovery. Capitalism creates incentives for investment and, over the long term, rewards those who can tolerate the short-term volatility.

In closing, stay safe, stay home, stay focused on what you can control, and please turn off the investment news channels.

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